Just before nightfall, Yezong Zumu seeks the charity of the caterpillar fungus diggers, whose mountain shacks offer respite from the bitter winds that slice across the stony Himalayan plain, 4,000 metres above sea level. A roof is all she needs until dawn, when she sets off again, chanting scriptures, fingering her prayer beads and slowly trekking around the sacred mountain, Xiannairi.

For almost all of her 67 years, it has been thus for this Buddhist - living close to nature, close to the spiritual and precariously close to starvation. It is not unusual in this southern corner of Sichuan province, where - such is the sense of the mystic, the beautiful landscape and the remoteness of the location - local people believe that they live in a real-life Shangri-la despite enduring the most wretched poverty.

But in recent years one of the fastest changes in world history has caught up with this remote place. First came the new road, then cars, electricity, TV and tourists. Now Yezong tells me - the only foreigner she has ever met - her family has an income. It has transformed her values. On this annual pilgrimage, she will pray for a good harvest, her family's health and peace. But asked for her greatest source of happiness, she says: 'Making money. If you have money you can do anything.'

In terms of UK history, Yezong has travelled from the medieval period to the 20th century in a decade, pulled aboard China's economic express which is powering through to the most isolated places on Earth. Interest in China's surging economy has largely focused on the new rich in Shanghai, Beijing and Guangzhou, but a bigger impact is on the old poor in provinces such as Yunnan, Sichuan and Shaanxi. This is the real achievement of a near 10 per cent annual growth. Never mind that a few million on the eastern seaboard can now afford Louis Vuitton bags and BMWs, what is incredible is that hundreds of millions of farmers no longer have to worry about where their next meal is coming from. Material success has cost dear, however, in terms of pollution, inequality and civil rights. Never mind, the communist government has always argued, our priority is food, shelter and clothing for 1.3 billion people. But now this task is nearing completion, what comes next?

The search for utopia starts in the foothills of the Himalayas in Yunnan, where virgin forest blankets what - until recently - was one of the planet's most pristine environments. Home to three of Asia's mightiest rivers, its greatest mountains and an astonishingly diverse mix of flora, fauna and ethnic minorities, this province has always been an ideal spot for those who like to look backwards and upwards for their earthly paradise. In Britain the most famous of them is James Hilton, who set his utopian Thirties novel Lost Horizon in the fictional land of Shangri-la. Although the author never came to China, he considered this region to be the antithesis of the grim industrialisation of the era. Now millions of wealthy Chinese - mostly from polluted cities - are flocking to Yunnan seeking a lost purity.

But these journeys create problems. Nowhere is this more apparent than in Shangri-la - formerly known by the less romantic name of Zhongdian - which has seen a rise in tourist numbers from 15,000 to 2.6 million in 10 years.

For anyone expecting tranquillity, the crowds and traffic in the town are as much of a shock as the signs for the Shangri-la branch of the Industrial and Commercial Bank of China, the Shangri-la Communist party headquarters or the 'old town' currently being built from scratch. But few seem to mind. Local people we speak to say they are pleased with the changes, which have raised incomes in one of China's poorest areas. 'There is damage from tourism, but it is better than in the past, when we relied on logging and mining,' says Zeren Pingcuo, a landscape photographer. 'The wonderful thing is man can do all this destruction and yet nature still shows its beauty.'

But the crush of humanity is taking an increasing toll. A glimpse of Shangri-la's future can be seen five hours' drive to the south-west in the mega-resort of Lijiang. A decade ago this tranquil community of bubbling streams, cobbled alleys and wooden homes was little known. Today it is a playground. Buses and planes arrive daily, disgorging their human contents into a fast-expanding city of hotels, bars and trinket stalls. At night the bubbling brooks are drowned out by raucous singing contests. There are few complaints, though. Progress has brought money and personal - if not political - freedom. Xuan Ke, pre-eminent musician and raconteur in Lijiang, was jailed for 21 years because of his family's association with foreign missionaries. Now 77, he regales tourists with a witty critique of a development model that is destroying local traditions.

'In China now there are no beliefs. People's lives are empty. They need a dream. The economic situation is getting better and better, but in politics there has been no movement,' he tells me. Nonetheless, he is optimistic. 'I believe we will see progress in the next five to 10 years.'

It is a confidence I find almost everywhere on the journey: from a Tibetan pig farmer, a Mongolian mausoleum guard, a Naxi housewife, a trekking guide, a wind-engineer, a beggar, a train guard, several monks, two army veterans, a policeman, a masseur and even a few environmental activists.

Our next destination is Yading - a Tibetan village in Sichuan province too remote to appear in most guidebooks, though locals claim this is the real Shangri-la. To get there our car traverses steep, slippery roads past several buses and trucks stuck in mud. The muzzy feeling in my temple is the altitude: more than 4,000m above sea level. Difficult to reach and largely unspoiled, Yading is close to Hilton's ideal. On the road we meet Yezong Zumu and countless caterpillar fungus collectors, who scour the slopes from dawn till dusk in search of the tiny stems. The fungus is used for Tibetan medicine, which, like everything else, is now a booming industry in China. They may find five in a day, each worth 15 yuan (£1), but this is good money.

Tourists are arriving in increasing numbers. Hotels and guides are cashing in. Women are arriving from faraway villages to work as waitresses and prostitutes. The provincial government talks of building a cable car up to one of the sacred sites. 'Our biggest source of happiness is the increase in tourists. Although their rubbish hurts the environment, they bring money,' says A Wangsiliang, fungus collector, Buddhist and secretary of the local Communist party. 'Our main worry is that the authorities will seize our land to build hotels, just as they did in the other Shangri-la.'

A modern Chinese dream is being fashioned from concrete: more dams, hotels and roads. At Kangding, signs announce the construction of a new airport in the clouds. Sited well above 4,000m, planes will be half the way into the sky on the runway.

But is there anything more to China's development than money? Next stop is Xian, the capital in the heyday of the Tang dynasty (AD618 to 907), when China was the world's most advanced civilisation. The city's political power has long since faded but it is important for Christians and Muslims. At St Francis cathedral the congregation for Sunday evening Mass is so large many must stand. Priests say contributions from local and overseas donors have doubled in five years, which has funded new schools, clinics and other social projects, including water treatment facilities. Father Stephen Chen tells me more people, particularly the young, are coming to church. He is optimistic Beijing will soon establish relations with the Vatican, and compared with the past Christians have more freedom to worship. 'Things are moving in the right direction,' he says. 'If people live according to a moral code or the teachings of one of the great religions - Christian, Buddhist or Daoist - we will improve society.'

There is a similarly upbeat message at the Xian Great Mosque - a series of ancient wooden courtyards which the guidebook says is the most famous Islamic centre in China. A mullah says worshippers have increased by 30 per cent in the past five years. At Friday prayers, the 2,000 places are filled. 'It is getting easier to worship,' says Ma Xinxian, a Muslim shopkeeper. 'Business is also improving. Life is getting better.'

In the evening I meet a priest from one of the underground churches which refuse to accept political control of appointments and procedures. There are occasional crackdowns but even this priest agrees the climate has improved. In Shaanxi province the rift between the underground and official branches of the church - each of which has about 100,000 worshippers - has closed.

Nobody would claim that China is a spiritual paradise, but attitudes are changing. Even in the Tibetan areas of Yunnan and Sichuan, where Buddhism is tightly controlled, the monks say more monasteries are opening and more people visiting as worshippers or tourists.

Marxist ideology has been undermined by the gulf between rich and poor, and the victory of competition over co-operation. It is evident in the crowds of beggars at the station the next day. Wang Chunlan, 80, left her Anhui home two years ago when her family were unable to grow enough food to feed themselves. Sleeping rough in the city, she says, is an improvement. 'In the past I had no income. I could only eat what we grew. But now every day I can get a few yuan. Today I was very lucky. A woman gave me 3 yuan (20 pence).' Prostitution, drug abuse, counterfeiting and organised crime are on the rise. Last year the government reported a record 87,000 public order disturbances. In appeals to the nation's morality, the government has begun mixing its communist rhetoric with Confucianism - evident in President Hu Jintao's oft-repeated aspiration to create a 'harmonious society'. On the train every carriage has a poster promoting the 'Eight Virtues and Eight Shames' - ideals advocated by the President in a speech this year. The conservative value system, which includes the dictum 'respect order, do not embrace chaos', owes more to old imperial hierarchies than the revolutionary ideals of the republic's founders.

Old values are still evident in Yanan, probably the closest China ever came to a socialist utopia. After the trials of the Long March in the Thirties, this city in Shaanxi province was Mao Zedong's base for 13 years before he took power. Children are taught this was a time of great hope, selfless community work, courage in the war against Japan, and the spread of free schooling and healthcare.

Today rising medical and education fees are the biggest worry for China's 800 million peasants. Overseas academics have revealed the bloody purges during that supposed golden age, but none are mentioned at the Yanan Revolutionary Commemoration Museum, a political shrine where visitors on the 'Red Tourist Trail' can see Mao's pistol and clothes, life-sized models of senior communists, and giant pictures of the 'Great Helmsman'. 'When I come here, I feel very proud to be a communist,' says Li Jun, a party secretary of a work brigade in Anhui. 'Although there have been big improvements in our lives, we must learn from the Yanan spirit to overcome adversity. The road is long, but I believe we can still achieve a communist utopia.' The communist party is growing - from 64 million to 70 million since 2001 - but the motivation for joining is now as likely to be a desire to enter the ruling class as social idealism.

We make an unannounced visit to China's only retirement home for non-commissioned veterans of the Red Army. It is Potemkin old people's home. From an army of millions, fewer than 30 enjoy the comforts of this quiet residence, which include a pension of 970 yuan (£72) per month, in addition to free accommodation and food. A nurse introduces us to Liu Tianyou, a 90-year old veteran selected to talk to President Hu when he visited earlier this year. Liu started her propaganda career in the 4th Army in 1933 and is still committed: 'The whole purpose of our revolution was to achieve communism. That is what we fought for. In a communist state you can have anything you want and everyone is the same. We are not there yet.'

Five minutes' walk away, we see just how far China is from that paradise. Wang Xiuling lives in a cave with her four children. It took them 12 days to dig their home, one of thousands that pock the hillsides around the city. It is dimly lit and decorated by a few posters and half a dozen basic items of furniture. 'This new home is for my children. I was brought up in a cave and to me it feels more comfy, but I don't want my children to end up living in one.' She is saving all she can to give her son a good education. There is not enough to do the same for her three girls, particularly now that her income - as a butcher - has halved in five years to just 1,000 yuan (£70) per month. 'Too many people are moving in to the city from the countryside. The competition is much tougher than in the past.'

Of the 28 people I interview on the journey, Mrs Wang is the only one whose income declined. For two, it remained the same. The rest cited substantial increases. More than 20 said they were twice as well off as in 2001. Even given the growth of the economy over that time, this was impressive - particularly because we were passing through some of the poorest provinces. For this the government must be credited. Rather than rely only on the trickle-down effect, it has diverted £114bn to deprived inland regions under the 'Go West' policy.

Most surprisingly, the majority of people I met said their living environments had improved. Despite numerous warnings of river pollution, smog, desertification and acid rain, most people believed their drinking water was cleaner, air quality better and the forest cover thicker than five years ago.

Were the reports wrong? Were people being duped by propaganda? Or were perceived improvements of the environment, like religious freedom, simply relative to the dire standards of the past? Driving through the grim terrain of northern Shaanxi province and Inner Mongolia, it was hard to imagine how much worse it could have been. Once past the loess hills (and thousands more cave dwellings), we hit Yulin, where part of the Great Wall has been knocked down and replaced by a row of shops and apartment buildings. Soon after, we hit a sandstorm, then hundreds of miles of desert and scrubland, punctuated by cement factories, gravel pits, power plants and the occasional coal dump.

It is hard to imagine anything less like Shangri-la than this blasted landscape. When the dust storms blow in - eight so far this year - few venture outside without face masks or scarves to cover their mouths and eyes. The deserts are creeping closer to the cities because of the climate and more than two decades of rushed development, over-exploitation of water resources and deforestation.

Yet local people insist life is getting better. Incomes are rising and a huge campaign to fight the desert by planting 12 billion trees has made the sands greener. Coal still rules but we visit China's biggest wind farm in Huiteng Xile, where - on a gusty day - the 94 turbines can send 68,000kw of electricity per hour to Beijing.

It is almost dark by the time we reach Shangdu, a town better known as Xanadu. Far from the 'stately pleasure dome' envisaged by Samuel Taylor Coleridge in Kubla Khan, the dishevelled town is an outpost in oblivion. We visit the ruins of Kubla Khan's summer palace. In the 13th century, this was the heart of one of the greatest land empires in history. Poets from the Yuan dynasty - founded by Kubla Khan, grandson of Ghengis - have described the excesses of the court, which hosted three-day feasts, with scholars and travellers from around the world. All that is left of that paradise is a square mile of grassy banks and stones on a windswept plain. There is no treasure, only the meagre takings of the ticket booth, in which the attendant is sleeping when we arrive. The only sign of life is some empty beer bottles and a snake asleep among the rubble. There can be few more forlorn examples of how empires can fall as well as rise.

China is in too much of a hurry to bother with ruins. We meet only two other visitors. One of them, Lu Zhiqing, an artist, is here in search of inspiration for a statue he has been commissioned to sculpt in Xanadu. Asked how China could avoid the pitfalls of the past, the 50-year-old talks about the environment. 'I am an artist, so I see things in terms of colours. When I was a child, the sky was so polluted that it was often yellow, red or black. It is better now, but we must do more. What we need in China is more green and more blue.'

Heading back to Beijing in another grit storm, the artist's colour code strikes me as a good a way of understanding China. Development has taken the country from the green of Shangri-la's primordial forests, through the communist red of Yanan to the industrial black lands of Inner Mongolia. The big question is whether it will end in the yellow sands that whip across the ruins of Xanadu and threaten cities as far away as Beijing.

It had been almost two weeks and 5,000km since I set out. We had followed part of the trail of the Long March and the Silk Road, crossed the torrents of the Yangtze and the almost dry Yellow river, passed through a gaping hole in the Great Wall, and been hit by altitude sickness and desert storms. I ended the journey with more hope than I started. In terms of raising living standards, China has come much further, much faster than many outsiders think; people are becoming aware of the need for a more sustainable model of development; and there is a hunger for something beyond the material. A brave minority are even willing to speak out about politics.

There was no utopia, no great drive for a religious or political ideal. Today the closest thing to a national religion is the worship of money, the only unifying belief a conviction 'life is getting better'. But there was a huge energy, immense optimism and an encouraging open-mindedness. Nobody expected paradise - communist or religious - any time soon, just an improvement in their daily lives and hopes for a China with 'more green and more blue'.